Racing Limited vs Her Majesty's Revenue and Customs

Those of you who are Formula One fans will remember vividly that in 2007 the McLaren team was fined USD100 million by the Federation Internationale de l'Automobile (FIA) because they had been engaged in a scheme (and I am not sure whether that is the correct word) whereby Nigel Stepney, a top mechanic with Ferrari, had passed information on to Mr Coughlan, the chief designer at McLaren.

My memory is that, at the time, this had seemed as shocking as finding out that Lance Armstrong is a doper! But as a result of having to pay this fine, there was a serious reduction in the gross income of McLaren.

The question for Her Majesty's Revenue and Customs (HMRC) was whether the USD100 million penalty was deductible against McLaren's taxable profits. In terms of English tax law there were two questions that arose - whether the loss from having to pay the penalty was connected to McLaren's trade, and whether the loss arose out of that trade.

Did the loss arise out of trade?

When this matter came before the First Tier Tax Tribunal in McLaren Racing Limited vs HMRC [2012] UKFTT 601 (TC), there was an extensive review of the English authorities concerning the question of whether the loss arose out of trade and was sufficiently closely connected to the trade.

In South Africa, s23(o)(ii) of the Income Tax Act, No 58 of 1962 (Act) prohibits the deduction of any expenditure incurred, which constitutes a fine charged or penalty imposed as a result of an unlawful activity carried out in the Republic or in any other country if that activity would be unlawful had it been carried out in the Republic. The issue in the McLaren case is that the fine was imposed by a private body and not by virtue of a statutory provision or other law. For instance, in the case of McKnight vs Sheppard (1999) 71 TC 419, the court had looked at fines imposed on a stockbroker by the Stock Exchange. At that time the Stock Exchange was a gentleman's club and was not regulated by statute. Lightman J held that neither the fine nor the legal expenses were allowable as a deduction. However, this matter subsequently went to the Court of Appeal and the House of Lords. They were happy to limit the deductibility to the legal expenses. Lord Hoffmann wrote the speech for the House of Lords and had effectively said that the reason that the penalty was not deductible is because its purpose is to punish the taxpayer and the court may easily conclude that the legislative policy would be diluted if the taxpayer were allowed to share the burden with the rest of the community by a deduction for the purposes of the tax.

As a result of obtaining confidential information from Ferrari, McLaren was fined a sum of USD100 million less its share of the income from Formula One in terms of the Concorde Agreement. That resulted in a loss of USD64.5 million nett. Mr Nawbatt for HMRC argued that the penalty was a loss for the conduct of McLaren's employees and their gathering of and intention to use Ferrari's information. It was conduct prohibited by Mr Coughlan's contract of employment and so was outside of McLaren's regular business. The penalty was not incurred in the capacity of McLaren's trade, but as a punishment for a serious breach of the rules. Mr James, acting for McLaren, had argued that there is a difference between the nature of a penalty levied by a body such as the Stock Exchange, which has a public function to protect the public (in South Africa see The Johannesburg Stock Exchange vs Witwatersrand Nigel 1988 (3) SA 132 (A)) and the nature of a contractual payment such as that paid by McLaren. He argued that the fine was incurred because the of actions of McLaren's employees, and even if they were unauthorised, it was incurred in the course of McLaren's trade. The fine was really for the use, rather than the possession, of the Ferrari information. Accordingly, it was not a punishment for McLaren personally, it was more of a commercial deterrent to others and so the cost was an inherent risk of their trade. McLaren was contractually bound under English law to pay the penalty.

Intimately bound up with its only source of income

The Tribunal, in analysing what was McLaren's trade, preferred the formulation that it was "trying to make money from the design and racing of Formula One cars". They preferred this formulation to "trying to make money by participating in Formula One racing subject to any rules imposed in the Concorde Agreement", because on that basis the employee's action would not be for the purpose of trade. The Tribunal did not believe that the word "trade" could be limited to exclude the contravention of another person's civil rights. Otherwise, when a taxpayer was assessed to tax, he could say "I am not taxable on that profit because it involves the contravention of another's right". Even though these activities of McLaren were not normal or ordinary, they were activities so closely associated with the mainstream of McLaren's trade that the Tribunal felt that they were part of it. The penalty levied by the World Motor Sport Council took account of the resources of the team and to be a deterrent sufficiently large to deter similar behaviour in the future. It was not a policy of personal punishment for McLaren. The penalty did not relate to the safety, health or wellbeing of the public. There was no consideration of public policy which required the penalty to be considered as disallowable. In considering the question of whether the loss was connected with the trade, the Tribunal was satisfied that had McLaren not traded the penalty would not have been incurred. The loss arose from McLaren's trade because it was intimately bound up with its only source of income.

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